Crane NXT, Co.

Greetings and welcome to the Crane NXT first quarter 2023 earnings call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jason Feldman, Vice President of Investor Relations. Thank you. Please go ahead.

Thank you, Operator, and good day, everyone. Welcome to our first quarter 2023 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On our call this morning, we have Aaron Sake, our President and Chief Executive Officer, and Cristina Cristiano, our Senior Vice President and Chief Financial Officer. We'll start off our call with a few prepared remarks, after which we will respond to questions. Just a reminder that the comments we make on this call may include some forward-looking statements. We refer you to the cautionary language at the bottom of our earnings release and also in our annual report on Form 10-K and subsequent filings pertaining to forward-looking statements. Also during the call, we will be using some non-GAAP metrics, which are reconciled to comparable GAAP numbers and tables at the end of our press release and accompanying slide presentation, both of which are available on our website at www.craneNXT.com in the investor relations section. Now let me turn the call over to Aaron.

All right. Thank you, Jason. And good morning to everyone. And thanks for joining our call today. As many of you know, this is our first earnings call for Crane NXT. And I'd like to thank all of our associates for their hard work and dedication as we executed our separation and at the same time delivered a very strong start to the year. Starting on slide five, we reported 97 cents of adjusted EPS for Q1. driven by 3% core sales growth with strong adjusted EBITDA margin of approximately 27%. Additionally, we had significant growth in our backlog, increasing by 34%. Overall, the results were ahead of our expectations. The outperformance was led by crane payment innovations, which delivered stronger than expected core sales growth of 10%. accompanied by more than 400 basis points of margin expansion with adjusted segment margins just over 30%. Consistent with our culture, these results were driven by the disciplined execution of the Crane business system and our dedication to continuous improvement. Crane Currency's results were consistent with our expectations. We remain very confident in our full year performance targets for currency given the strong order rate and backlog growth in the quarter with core orders up 36% and backlog up 132% compared to last year. Our cash flow performance was also strong and in line with the normal seasonality of the business. We remain confident in our plan to achieve approximately 100% adjusted free cash flow conversion this year. Given the strength of our first quarter results, we're raising the midpoint of our full year adjusted EPS guidance by 10 cents to the range of 375 to 405. Well, those are the highlights of the quarter, and Christina will walk you through in more detail our financial performance in a few minutes. Now, as I mentioned earlier, this is our first earnings call, and given this, I'd like to focus on why we have such an exciting investment thesis here at Crane NXT. As shown on page six, NXT is an industry leader providing trusted technology solutions to secure, detect, and authenticate what matters most to our customers. We have two industry-leading businesses, Crane Currency, which provides proprietary technology to secure currency and other high-valued physical products, and Crane Payment Innovations, or CPI for short, which offers detection equipment and systems, aftermarket services, and connectivity solutions focused on detecting and authenticating payment transactions. We finished 2022 with our strongest year in company history with revenue of $1.3 billion, approximately 40% of which comes from reoccurring and recurring revenue, adjusted operating margins of 28%, and adjusted free cash flow conversion of 116%. This is the financial profile you would expect of any premier industrial technology company, and I believe our Q1 results certainly reinforce this position. As we discussed at our March 9th investor day, our core business is resilient with mid single digit growth through multiple economic cycles. Additionally, we have very clearly demonstrated our ability to drive operational improvements through the deployment of the crane business system over many years. This is truly a hallmark of the company and has resulted in best in class financials and very strong free cashflow conversion. And that financial profile is built upon a number of core strengths and capabilities, including our technology leadership demonstrated through launching new and innovative products. For example, during the first quarter, Crane Currency launched its next generation of banknote security technology named Rapid Vision, the world's first multicolor micro-optic security thread for banknotes. This product retains the eye-catching movement proven durability and easy printability of Crane Currency's existing line of products, while also providing a broader range of fully customizable multicolor movement effects, the design possibilities with rapid vision are even larger, counterfeit resilience even stronger, and verification by the public is even easier. We launched this product at our recent conference in March, held at our state-of-the-art banknote printing facility in Malta. This event was attended by more than 100 central bankers and industry partners from 45 nations. That event, along with the features of this product, have already generated a strong pipeline of customers for Rapid Vision, with one central bank already specifying the product in its top denominations. Rapid Vision is a further extension of the product portfolio we have built and commercialized over the last 15 years, starting with motion switch technology that is most well known to many of you for its use on the US $100 bill. And that culture of innovation is just as strong at CPI with differentiated capabilities in the design and manufacturing of detection systems and image recognition software built on advanced algorithms to authenticate products. For example, in the first quarter, CPI deployed the new AlioPro terminal for processing credit card and mobile payment transactions paired with our Simplify cloud management platform for electric vehicle charging applications in Europe. We successfully integrated the solution with EV charging OEMs, and we're launching a program involving a major hotel chain in the UK. These are both examples of the continued focus we have at NXT of extending our technology leadership and developing products that solve our customers' most important challenges. Another hallmark of our company is our disciplined operational execution built on the tools and resources of the Crane business system. It's with this same focus on operational excellence that we developed our formula for shareholder value creation as shown on slide seven. It starts at the top of this image, built on a foundation of a very resilient core business growing at mid-single digits. We continue to deploy CBS to increase margins and improve productivity in the core. This generates our strong free cash flow conversion of approximately 100%. We put this free cash flow to work through our disciplined capital allocation strategy. This includes investment into the core business, paying a competitive dividend, and deploying to M&A, targeting higher growth and resilient end markets. This cycle is continuous, and over time, it will clearly position NXT as a strong compounder, creating significant shareholder value. And as part of this value creation strategy, we've set very clear goals for the business over the next five years. Through a combination of organic growth and M&A, we plan to grow the business to $3 billion in revenue, growing at mid-single digit plus. We'll maintain high 20% operating profit margins, along with free cash flow conversion of approximately 100%. To achieve this plan, we'll focus on three priorities. continuing to invest and grow our core business. Second, focusing on operational excellence through CBS to expand margins and drive our free cash flow conversion. And third, executing our proven playbook on M&A to further expand and diversify the portfolio into near adjacencies. Through the combination of these actions, we plan to move from a mid-single digit to a mid-single digit plus growth portfolio. Additionally, Today the company has low leverage of approximately 1.7 times net debt to EBITDA. We plan to keep our leverage at less than three times as we execute this strategy. In total, these clear measures of success position NXT both now and in the future to be a leading industrial technology company and create significant value for our shareholders. So with that, let me pass the call over to Christina, who will provide additional details on our financial performance in Q1, capital structure, and our updated full year guidance.

Thank you, Aaron. And I'd like to thank all the Crane NXT and Crane Company Associates for their incredible commitment to complete the separation of our two fantastic companies. We are so appreciative of your hard work. As Aaron mentioned, we have a very strong start to the year. As shown on slide 9, adjusted EPS of 97 cents was ahead of our expectations. Core sales growth was solid at 3%, and we delivered strong margins, with 23.3% adjusted operating margins and 26.7% adjusted EBITDA margins. Moving to slide 10, Crane Payment Innovations had a great quarter, with core sales growth of 10% driven by a combination of solid end customer demand and some easing of the supply chain constraints that we've been managing over the last few quarters. The improved supply chain conditions allowed us to ship products out of our backlog earlier than we originally expected. Adjusted segment margins increased 420 basis points to 30.1%, reflecting strong pricing, positive mix from increased shipments of backlog, lower inflation, and the execution of productivity programs throughout the business. We had a lot of exciting activity in the quarter. We had great price execution and broad-based strength across most vertical markets, led by gaming, where we have been very successful with both new casino openings and converting new customers to our solutions. A significant part of our success in this market is our ability to pair best-in-class payment validation hardware with our comprehensive EasyTrack software solution. Moving to Crane Currency on slide 11, the quarter unfolded as we expected. As we explained last quarter, we are seeing lower U.S. production volumes, as the Bureau of Engraving and Printing focuses on the $10 bill redesign program, as well as a higher mix of lower denomination bills. The international currency business continues to perform very well, and you can see that reflected in our 132% backlog growth this quarter, which gives us confidence in our ability to deliver on this year's expectations. And in this market, Crane Currency continues to take new market share with our banknote security features. Two recent examples include high-value banknote denominations, with both Iraq and Argentina adopting Rapid HD micro-optics security thread. And we were awarded the first banknote series in the world to feature both motion surface and Rapid HD detect together on the same banknotes, which will launch in 2024. Moving to slide 12. Cash flow was solid in the quarter at 33 million, consistent with normal seasonality, and we are confident in achieving an adjusted free cash flow conversion ratio of approximately 100% this year. Our capital structure is strong and flexible, and slightly improved from our previous guidance. As of April 4th, we held cash of approximately 270 million, and we had total gross debt of approximately 900 million. Based on that, net debt is 630 million, and using our adjusted EBITDA guidance, net debt to EBITDA is approximately 1.7 times. This gives us approximately $1 billion of M&A capacity and substantial flexibility to deploy capital in a manner that best maximizes shareholder returns. Moving to guidance on slide 13, as Aaron mentioned, we are raising the midpoint of our adjusted EPS guidance by 10 cents to a range of $3.75 to $4.05. Compared to prior guidance, we are seeing slightly higher interest expense in 2023, now at $50 million, given the higher rate environment. More than offsetting that, however, will be a combination of modestly higher margins and core growth that is now likely to be in the upper half of our 2% to 4% range. The key drivers of the business remain unchanged from what we discussed at our recent Investor Day. At CPI, we have strong secular trends supporting investment in automation and productivity and we are seeing some modest improvements in the supply chain. The segment is off to a better than expected start to the year and should deliver strong core growth and margin improvement in 2023 and beyond. At Crane Currency, we continue to gain share in the international business and in product authentication. The U.S. business is performing as expected with somewhat lower production as the U.S. government prepares for a series of newly redesigned bills, which is a very good opportunity for us in the years ahead. Overall, our investment thesis is unchanged. We had very solid execution in Q1, and we are optimistic for the remainder of the year. Let me now hand it back to Aaron for a few closing comments.

All right. Thanks, Christina. Well, as we come to a close of our prepared remarks, I want to summarize our key messages that we discussed today about Q1, and that's provided on page 14. Our performance across multiple metrics was better than expected. This includes orders, sales, and operating profit. This was driven by our focus on continuous improvement deployed through the Crane business system to drive both growth and profitability. Given our results and outlook, we're raising the full year EPS guidance by 10 cents to the range of 375 to 405, and we continue to have very strong balance sheet for future capital deployment, as Christina mentioned. And with that strong position and start to the year, we're confident in our ability to deliver on our five-year goals to grow NXT to $3 billion in revenue by executing our strategy. And that's shown on page 15. We're a leading provider of trusted technology solutions to secure, detect, and authenticate our customers' most valuable assets. We have a durable, resilient business growing at mid-single digits with best-in-class margins and free cash flow conversion. We have a strong balance sheet with substantial capital available for acquisitions, a great track record of disciplined M&A generating high returns, and we're focused on expanding the business via M&A to adjacent higher growth in markets. Our performance in Q1 is a very important step in this journey. and it gives us continued confidence in achieving these objectives. Now before I close, I'd again like to thank all of our associates around the world for the hard work that they put in and their dedication to enable a very strong start to the year and a very strong start to Crane NXT. So thank you for your time this morning, and Donna, we're now ready to take our first questions.

Thank you. Ladies and gentlemen, the floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. Our first question is coming from Matt Somerville of DA Davidson. Please go ahead.

Thanks. Good morning. Wanted to spend a few minutes maybe first talking about currency. Is there a way to frame up, Aaron, how much time the BEP is taken off of the print shop, so to speak, to dedicate to the forthcoming redesign cycle? And to that point, when should you start to keep inbound orders from the USG as it pertains to the 10 that I believe is supposed to go into production in their government year, fiscal 25? And then I have a follow-up.

Sure, sure. Hey, good morning, Matt, and thanks for that question. So I would say broadly speaking, as we've been discussing, Matt, we're on track with the work with the BEP. We feel very good about that in our relationship. As I believe we mentioned in our investor day, you know, we'll be looking at some upgrades inside of our facility that starts at the end of this year and beginning of next year to prepare for that $10. So as you can imagine, that's perhaps relating to some of the changes just in production that I think you're alluding to. Again, I would say it's going as planned and kind of as what we expected. In terms of actually, you know, seeing orders, you know, I need to comment, I think, as you know well, we haven't really received the contract for that. We feel very, very good about that and given our longstanding relationship. But we'd be looking well into 24 and 25 as you'd really start to scale up production. So I think it's still many quarters out, but everything is on track, and we feel very good about where we're at.

And then as a follow-up, maybe I'll just move over to CPI. You provided a little bit of color on the gaming side of the business as being strong in the quarter. You talk about four main focus on markets, those being gaming, retail, financial services, and vending. Can you maybe talk about performance more broadly speaking across each one of those four important buckets for CPI and what the outlook is for this year?

Sure. Sure. Thanks, Matt. Yeah, I would just reiterate to the remarks Christina made. You know, gaming's been strong for us this year. It was strong for us last year, too, as you might remember. As our portfolio, we think, is the best in the industry, both in the hardware and the software. And we've taken share over the course of the last several quarters. That's continued, and we still see strength in that. that bled, you know, read through here in Q1. We're going to see that, we believe, for the rest of 2023. Financial services remain strong for us. Those are, again, larger ticket and some smaller ticket equipment and services. That remains strong, and we're confident in our performance there, again, driven by the secular trends of increased automation in that market. Retail, again, particularly as we think about the longer-term secular trends here of labor scarcity and the drive for more productivity leading to automation and self-checkout, we still believe in that very strongly. I think both retail and vending would be the two markets that are a little shorter cycle for us, and one we're going to watch closely, order rates, I think as the year progresses. Again, off to a strong start in Q1, but given that that's the shorter cycle for probably more sensitive part of our business. That's, again, where we'll look to order rates and what's happening in the back half of this year. I would say overall, Matt, kind of everything in CPI coming in as expected. And as Christina mentioned, with some of the improvements we did see in the supply chain, thanks to the team's execution, we were able to convert a little bit more of that backlog in Q1.

Understood. Thanks, Aaron.

Thanks, Matt.

Thank you. The next question is coming from Bob Labick of CJS Securities. Please go ahead.

Good morning and congratulations on a great quarter and great start to the new NXT. Hey, thanks, Bob. I appreciate that. Yeah, absolutely. So I wanted to just kind of follow up on the answer from the last question as well. You talked a little bit about the upside in CPI coming from improvements in supply chain and inventory and whatnot. Can you give us a sense Are you fully caught up now? Are you still restrained? What areas are headwinds or how should we think about just the normal cadence of business in CPI and any remaining hangover or headwinds from supply chain?

Yeah. You know, Bob, we still have very strong backlog in CPI. You know, like all companies of similar products, particularly where you're relying on PCBs and electronic subcomponents, It was a challenging last several years for anyone in that space, and we were not immune to that. I think the team's done an excellent job helping us to get caught up and improve the supply chain. I would say it's not getting worse. It has gotten better for us in the last quarter, but there's still some episodic issues in the supply chain. I don't think we're fully through it, but it is improved, and I think that's what led to, in part, some of the over-delivery in Q1 for CPI.

Okay, great. And maybe just to expand on another point as well, if you look back to a year or so ago, we were, quote, almost certain to be in a recession by now. Obviously, things are going okay. I'm not going to make any forward predictions here, but I want to take advantage of that. Can you tell us about the economic sensitivity of CPI you mentioned? I think vending and retail have shorter cycle times. Just talk about the end markets and which ones are more or less sensitive to to the economy and how you view those and what signals you're getting from them.

Yeah, and maybe I'll take that, Bob. Thanks for the question and just talk about NXT broadly. I think it's important to point out a little over 40% of our revenue is reoccurring or recurring. That is not sensitive in the near term. Those are the long-held currency contracts that we have or service agreements inside the CPI business. So that's a substantial part of NXT in total. And then when you get to the balance, or let's say that 65% or so, or excuse me, the non-recurring or recurring side, there's also currency contracts that make up part of that business that we wouldn't classify in recurring or reoccurring. And we had a very strong order intake in Q1, as you saw, a very strong backlog. So I think we feel very good on that for the balance of the year. And then to the question that Matt asked earlier and you were asking, you get into CPI and there are four main verticals. Again, strong performance in gaming. We don't see necessarily any significant risk there in the balance of the year, a very strong backlog. And again, I think a winning product portfolio that has us continuing to gain share. Financial services is strong. And then retail and vending, again, I think our position there is very strong, particularly in self-checkout. where we have excellent relationships with OEMs, with system integrators that are becoming more important in that market, and the end customer as well. You know, we had strong orders in Q4. We've seen, you know, new lanes go online in Q1, and we feel good about the funnel in that business, but that is the shorter cycle side of the business, along with vending, and we'll be watching it But again, I think overall CPI performing in Q1 better than our expectations. We see a strong funnel even in the shorter cycle parts of that business.

Okay, that's great. And then maybe showing my new a little bit here, but I'm sure others could benefit from this question as well. Could you talk about the backlog in crane currency? It sounds like it was implied it relates all to or mostly to international, but obviously a huge pick up year over year. How should we view the backlog in general in Crane Currency as a forward indicator, and what was the big jump this year over last year?

Yeah, thanks, Bob. I'll take that one. We had a significant growth in the backlog in currency, as you saw, and you're right to say it was largely related to the international side of the business. So really just timing of international orders. As you know, the business can be a a strong increase in Q1 related to a few big customers. And so that's, you know, we know for the full year we've got a very strong backlog and orders lined up. So the full year is very solid, but that timing can vary from quarter to quarter.

Okay, great. And then maybe one more for me and I'll jump back in queue. But at least the capital allocation in M&A, it's probably too soon to talk too much more, but, you know, as you're just standing up the company, but Maybe in this forum, talk about your criteria for M&A and your pipeline and give us a sense of general timing. If you could time things, I know that's not always in your control or anyone's control, but how you're thinking about it broadly would be great.

Sure, Bob. Well, I'll take that last comment. Timing is everything, and I've never been in a place where you can time it that perfectly. Certainly, I won't comment on anything specific in terms of targets or actions on M&A. But, you know, I'd go back to kind of our process here. You know, we want to start first with the market focused on areas that we think can really accelerate the strategy. So call that a strategy-first approach around secure, detect, and authenticate. Then look at the company itself that could be a potential target and make sure that there's differentiation in their technology, brand, or channel, the right size to give us some scale. And then, you know, most importantly, at the end of the day, that we can be good owners of that business and generate a strong return for our shareholders. You know, I think about that as the criteria. With that said, we feel very good about the funnel. You know, as we talked about, we had a funnel coming in to the separation that we had paused. through the separation and that it was very public. We weren't going to do any M&A during that period of time. And since then, we're seeing opportunities. We're out actively cultivating. And again, we will first and foremost take a very disciplined approach to this. So, you know, patience here is a key word. We want to make sure it's on strategy. It's the right asset. We can be good owners and we can deliver value. You know, with that said, I also know probably to the nature of your question, this first deal for us is very important. So, again, it speaks to discipline and patience, and that's how we're executing, you know, the play here of how we think about when and exactly which target to execute on. So hopefully that gives you a little more color, Bob.

Absolutely.

Yeah, that's great. Thank you. I'll jump back.

Thank you. The next question is from Matt Somerville of DA Davidson. Please proceed with your follow-up question.

Thanks. I realize you can look back at the history of the old payment and merchandising technology segment, but given that the business, to your point, can be a bit lumpy from quarter to quarters, is there anything you can do to kind of help us out with respect to how we should be thinking about kind of the go-forward earnings linearity from quarter to quarter for the balance of the year? Anything that you'd like to point us to?

Yeah, thanks, Matt. And you're right. And certainly, you know, this year, you know, Q1, we had a tough comp on the currency side, as you know, and we've been talking about. And, you know, that read through here are kind of in line, as I said, with expectations. You know, I think when you think about the linearity, you know, first maybe think about the revenue linearity of the year. You know, we're going to be slightly weighted to the second half of the year this year. It depends on the year, but I think I'd think about it that way for this year. But we're going to see some improvement in margin rates, likely driven out of the currency side of the business just due to mix. As Christina mentioned, we started to execute a different part of the international backlog. You know, the U.S. side of the currency business is continuing to provide a little bit of headwind as we've seen the mix to the lower denomination $1 bills. We expected that coming into the year. You know, volume and mix has largely been on target. So, you know, nothing fundamental there. But really, this driver, if you kind of work that math through, would suggest, you know, again, we'll see an increasing margin as the year progresses. That's consistent. with also our updated guidance that we gave today, Matt, of saying it's 27% plus margins. Obviously, that's margin improvement from where we ended Q1, and that's driven by really the increased mix we expect out of currency. And with that said, the headwind that Christina pointed out is an interest expense, non-operational for us, but one that is going to read through simply due to the higher rates that have rolled forward. So hopefully that gives you a little color, Matt.

Yeah, for sure. Maybe then, just for my final question, if you can maybe talk strategically a little bit, Aaron, updated views on authentication, the growth trajectory, what's needed to really break into and unlock that TAM. I don't have the deck in front of me, but I thought – You identified it as the $5 billion TAM growing at healthy double digits. So what's the playbook look like there?

Yeah, well, I think, you know, similar to the rest of the business, thanks for the question on that one as well, Matt. You know, we're bullish on that market. We think that's, you know, where our core technology and micro-optics sits. We have very unique defensible position with wide moats around it in a market that's continuing to grow rapidly. from secular drivers around the need for any counterfeit technology, whether that's in luxury goods, tax stamps, or you name it. For us to unlock it, it's going to take two things. One, it starts with our organic efforts, which we've set up a team dedicated to product authentication. And as we mentioned in our last quarter, we expect that business, while small, still to have very high growth this year. And we feel very, very confident in that high growth in 2023. I think to really unlock that part of the market, it goes back to a prior question around M&A. And that's where we're spending time in developing the funnel, cultivating opportunities, and would be one of the areas we've highlighted where to really gain scale and create a bigger moat for NXT in this market, we will need to deploy M&A.

And if I can, maybe I'll just lob in one other one here, why I'm thinking about it. Within Crane Currency, talk a little bit about the competitive behavior you're seeing in the market. I mean, it's been pretty widely publicized that one of your larger competitors is struggling a bit, to say the least, from a financial perspective.

Yeah. You know, I think, again, currency continues to perform very well. You know, it's a tale of two businesses of the U.S. government side. which is, in some ways, given the nature of the contract, has a very wide moat around it, and again, is in line with expectations to the question you asked earlier, and we feel bullish on that long term. When you think about the international side, that team has been executing very well for the last several years, and that continued in Q1, and you can see that by the backlog growth that Christina mentioned earlier. So we wish certainly no ill will on anyone in the market, but I would first say we look in the mirror at ourselves and provide the best product with very high quality out of both in Malta and in our other factories around the world, whether that's papermaking or with our micro-operative thread, world-class operations that continue to have us gaining share. So again, feel very good about the positioning of that business, and I'd have to leave you know, comments to others in the market for those folks to answer.

Thanks, guys.

Thank you. This brings us to the end of the question and answer session. We would like to thank you for your participation in today's event. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.